Shares of Starbucks Corporation (NASDAQ:SBUX) are trading off more than 3% today after the company reported lousy Q2 earnings. SBUX stock had soared into the report on hopes that comparable sales trends would get back on track.
Instead, the company reported that they were just as bad as last quarter.
It seems to be settling into a new era of slow growth, and that only means bad things for SBUX stock. I say the stock is a strong sell here.
Here’s why.
Starbucks Stock: Traffic Problem
Average ticket was up 4% in the quarter, but transactions were down 2%. That means the positive comp is being driven by price hikes, not by increased traffic. That is a bearish trend for SBUX stock.
Management is blaming it on a change in the loyalty program, which last year provided incentives for customers to split multiple drinks into multiple orders. That is no longer the case. Consequently, management is partially blaming the transaction decrease on order consolidation.
It also looks like the mobile order-ahead system, while quickly gaining in popularity, may be getting ahead of itself. The system is causing some churn due to crowds at the pick-up stations. Management said that these problems have been addressed, and that sales momentum picked up throughout the quarter and into April.
If you just look at these two reasons for the drop in transactions, then you’d be long-term bullish on SBUX comp trends. But such a narrow view lacks the most important element of Starbucks’ recent struggles: Competition.
Competition Is Heating Up for SBUX
The reality is that transaction growth started showing cracks 3 quarters ago. In Q3 of 2016, SBUX reported flat consolidated transaction growth, the slowest mark since 2009 (it had been trending in the low-to-high single-digit range before that). In Q4, transaction growth went negative (-1%) for the first time since right after the Recession. That transaction growth stayed at -1% in Q1 of 2017. Now, it has continued to stay at -1%, but on a weaker lap (+2% versus +4% last quarter).
Yes, this is predominantly a U.S.- and Europe-led slowdown, but even in the company’s high-growth CAP (China/Asia-Pacific) segment, +10% transaction growth two years ago has turned into +1% transaction growth today.
While there are undoubtedly some loyalty program changes and mobile system disruptions in the fold, the truth is that SBUX has had trouble with traffic growth for a full year now. No matter which way you slice it, traffic growth is getting worse quarter-by-quarter.
And its happening everywhere. Meanwhile, McDonald’s Corporation (NYSE:MCD) just reported a strong quarter in which comp growth accelerated. Dunkin Brands Group Inc (NASDAQ:DNKN) has reported that Dunkin Donuts comps have remained stable in the +2% range. There has also been an explosion in boutique coffee-house popularity, as consumers seek a less corporate vibe when enjoying their morning latte.
Bottom Line on SBUX Stock
No matter which way you look at it, Starbucks is losing traffic share. McDonald’s and Dunkin Donuts are attracting consumers who want to pay 2 bucks for a coffee as opposed to 4 bucks, while boutique coffee shops are attracting consumers who want a less corporate vibe. Together, the price-driven and vibe-driven consumers make up a pretty big slice of the pie.
As traffic continues to migrate to other options, Starbucks will find it increasingly difficult to hike prices without further dampening already depressed traffic trends. Without price hikes, comps could very well go negative in the near future. That alone would kill SBUX stock.
At 24-times next year’s consensus earnings estimate, Starbucks stock has a ridiculous valuation that is richer than Facebook Inc’s (NASDAQ:FB) valuation. That is nonsensical, and puts the stock at serious risk to any and all operational hiccups.
At this point, SBUX stock has nowhere to go but down.
As of this writing, Luke Lango was long FB.
